Please rotate your device to landscape mode to view the charts.

Fintech, Regulatory Arbitrage, and the Rise of Shadow Banks

Journal: Journal of Financial Economics

Date: 20181201

Author: Buchak, Greg; Matvos, Gregor; Piskorski, Tomasz; Seru, Amit

Abstract:
Shadow bank market share in residential mortgage origination nearly doubled from 2007 to 2015, with particularly dramatic growth among online "fintech" lenders. We study how two forces, regulatory differences and technological advantages, contributed to this growth. Difference in difference tests exploiting geographical heterogeneity induced by four specific increases in regulatory burden-capital requirements, mortgage servicing rights, mortgage-related lawsuits, and the movement of supervision to Office of Comptroller and Currency following closure of the Office of Thrift Supervision--all reveal that traditional banks contracted in markets where they faced more regulatory constraints; shadow banks partially filled these gaps. Relative to other shadow banks, fintech lenders serve more creditworthy borrowers and are more active in the refinancing market. Fintech lenders charge a premium of 14-16 basis points and appear to provide convenience rather than cost savings to borrowers. They seem to use different information to set interest rates relative to other lenders. A quantitative model of mortgage lending suggests that regulation accounts for roughly 60% of shadow bank growth, while technology accounts for roughly 30%.

Link: Google Scholar

Background and Context

Research Setting

The study examines the dramatic transformation of the US residential mortgage market between 2007-2015, focusing on the rise of shadow banks and fintech lenders.

Data Sources

Analysis uses comprehensive loan-level data from Home Mortgage Disclosure Act (HMDA), Fannie Mae, Freddie Mac, and FHA databases covering the majority of US residential mortgages.

Methodology

Combines empirical analysis of lending patterns with a quantitative model to decompose the effects of increased bank regulation and technological innovation on market structure.

Dramatic Rise in Shadow Bank Market Share

  • Shadow bank market share in residential mortgage origination nearly doubled from 30% to 50% between 2007-2015
  • Growth accelerated particularly after 2011 coinciding with increased bank regulation
  • Represents a fundamental shift in mortgage market structure

Growth of Fintech Lenders Within Shadow Banking Sector

  • Fintech lenders grew from 3% to 12% of shadow bank originations between 2007-2015
  • Represents significant technological disruption in mortgage lending
  • Growth concentrated in refinancing market segment

Higher Interest Rates Charged by Fintech Lenders

  • Fintech lenders charge 14-16 basis points higher interest rates than traditional banks
  • Non-fintech shadow banks offer slightly lower rates than traditional banks
  • Suggests fintech lenders compete on convenience rather than cost

Impact of Regulatory Burden on Bank Lending

  • Regulatory burden on traditional banks increased substantially after 2011
  • Coincides with implementation of Dodd-Frank Act and Basel III rules
  • Created opportunities for shadow banks to expand market share

Decomposition of Shadow Bank Growth Drivers

  • 60% of shadow bank growth attributed to increased bank regulation
  • 30% of growth driven by technological innovation
  • Remaining 10% explained by other market factors

Contribution and Implications

  • Documents fundamental transformation of US mortgage market structure driven by regulation and technology
  • Demonstrates how regulatory burden creates opportunities for less regulated financial institutions
  • Shows fintech innovation enables new business models but may not reduce borrowing costs
  • Raises important questions about stability and regulation of new lending institutions

Data Sources

  • Shadow bank market share visualization based on Figure 2 and Table 1
  • Fintech growth visualization based on Figure 3 and Table 1
  • Interest rate comparison based on Table 6
  • Regulatory burden impact based on Figure 6 and Table 8
  • Growth decomposition based on quantitative model results in Section 9.4